Why global interest rates may further drop

Because of changing demographics and the pool of global investment and savings, interest rates may further drop.

More investors are looking for returns, causing asset prices, properties and shares to bid up as returns continue to drop. This is structural and may not change any time soon, so global interest rates may even go lower, with the flow on to inflation.

In the last 30 years, world interest rates were pushed down by as low as 450 basis points because of lower relative price of capital, lower public investment, higher costs of financial intermediation, greater private deleveraging, as well as income distribution and demographics.

The increased retirement savings due to the ageing global population and longer life expectancy have lowered the global interest rate by about 140 basis points since 1990 and by 2025, it could further lead to a 35 basis point drop. These could persist after demographic trends have stabilised because the stock of savings matters, and not the flow.

If we change income distribution, the global integration of labour markets could lower global rates. Income has shifted to skilled workers, who have a higher propensity to save and rising incomes in emerging market economies may reinforce it as saving rates are structurally higher there. The high mobility of capital across countries means that returns will move together closely, with marked divergences arbitraged.

Global factors drive domestic, long-run real rates at high and low frequencies and influence domestic financial conditions relative to the short-term equilibrium rate of monetary policy and rates as well. Borrowers and lenders in different countries develop financial conditions that can be transmitted across borders.

According to the Bank of England, a single global factor accounts for over 40% of the variation in domestic financial conditions across advanced economies.

Factors also include sentiment and risk aversion. UK has the world’s leading global financial centre and a third of its business-cycle variation policy rate may be attributed to factors originating abroad.

Monetary policy is important. Global term premia may rise in the coming years as net asset purchases shift significantly from the past four years when all net issuance within the G4 was absorbed effectively.

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